The Advantages of Owning Stocks in Estate Planning

April 1st, 2006

Individual stocks have advantages over other types of investments when it comes to estate planning. They offer a cost effective way to reduce income taxes, can easily be sold if necessary, and offer an effective way to pass on your values to your heirs.

Income TaxesStocks are able to reduce income taxes because their cost basis gets “stepped up” to their value on the date of death. This eliminates capital gains taxes for your heirs. Yes, other types of investments will also receive a stepped up cost basis, but few have the potential to build up large untaxed earnings that will benefit like stocks can. Let’s compare stocks with several investment alternatives:

Stocks vs. Bonds
Bonds earn most of their return from interest that is taxed each year. Therefore, they do not build up large untaxed gains that would benefit from the step up of cost basis.

Stocks vs. Annuities
Annuities do not get the “Step up” of cost basis that stocks receive. Instead, all of the tax deferred income that has built up in the annuity becomes taxable income to your heirs. Since many people have annuities that have built up earnings for years, that tax can be quite high.

Stocks vs. Mutual Funds
Since mutual funds distribute their gains to you almost every year, you do not get the big buildup of gains that will benefit from the step up. Instead, more of the gains get taxed each year. Conversely, individual stockholders who sell their losers each year to reduce annual income taxes, and hold the winners for years, can avoid substantial capital gains taxes.

Liquidity
Real estate also gets the “step up” in cost basis when passing to your heirs and also tends to build up large gains over many years. However, real estate is more difficult and more costly to sell. It may also be difficult to divide up among your heirs. If an estate is short of cash needed to pay expenses and estate taxes, or the heirs want to cash in their separate shares, the estate may be forced to sell a large property at an inopportune time. Comparatively, stocks can be easily and selectively sold to raise the amount of cash needed. Stocks can also be easily divided among multiple heirs without being sold.

Cost
Life insurance, which is sometimes used as an investment vehicle, also offers a way to avoid income taxes on earnings since death benefits are not subject to income taxes. However, the mortality expenses inside life insurance policies make them an expensive way to invest. Some people mistakenly believe that life insurance benefits will also avoid estate taxes. It is important to note that life insurance benefits, just like stocks, are included in your estate and may be subject to estate taxes.

Legacy Planning
Stocks can also be an effective tool for legacy planning. If you consider social values a significant factor when choosing investments, stocks can provide a clear message to your family about the issues you value most. Although there are socially responsible mutual funds, such funds can have vague guidelines that do not match the investor’s real goals. For example, one gentleman who had a strong interest in labor issues purchased shares in one of the largest socially responsible mutual funds. He was very disappointed to find the fund owned Nike which manufactures its shoes in third world countries paying minimal wages. By selecting specific stocks that meet your standards, you can achieve your goals and make your social values very clear, thereby leaving a legacy for your heirs.